A Post-Summer Investment Risk Checkup

Like you and so many other value investors, I’ve spent the summer waiting for the other shoe to drop. For investors, it’s been a slow past couple of months as stocks have moved lazily higher, seemingly defying gravity. The most hated bull market in awhile charges on with the S&P 500 pushing through its all-time record highs.

The lack of major geopolitical events this summer has certainly supported record prices. Unlike the past several years, financial markets have not had any reason to move downwards; they’ve not been impacted by any doomsday dramas such as a potential Grexit or a Chinese economic meltdown. Even the June British referendum on the EU had only a transitory negative effect.

Additionally, whatever state the economy is in, it’s also supporting the record high stock valuations. Economic indicators are confounding many with marginal improvements in one area while backsliding in others. Broadly speaking, the economy seems to be improving at a glacially slow pace and markets have been hesitantly creeping upwards in a correlated way.

Valuations have increased even as corporate growth has stalled and economic forecasts at best look unsteady. GDP growth projections for the advanced economies suggests that things will not be getting better fast.

So, very little has changed in the risk environment to convince me that higher and higher levels of equity valuations are justified. I have only to look at corporate earnings. An earnings recession has lasted for over 4 quarters. This is a stark indicator that corporate growth is struggling in an unfriendly economic environment.

As well, main street Mom and Pop investors, who are historically more conservative, seem to be buying equity, particularly dividend generating stocks, simply out of a search for yield and a hope that earnings will improve. Presently, the vast majority of S&P stocks have dividend yields greater than the risk-free U.S 10-year. As a result, equity looks like a very attractive carrot dangling before our eyes.

Moreover, the smart money has pulled out of equity, it’s either waiting on the sidelines or found other yield-generating investments to pour capital into. Institutional investors have taken out downside protection in record amounts last seen back in 2007.

My Roadmap through the Hazards

Clearly, the investing environment has become riskier over the past few months. As well, in a low or no-growth earnings environment risk of loss increases disproportionately as stock prices increase.

As a value investor keeping my portfolio risk from increasing means that I’ve been trimming back on holdings as markets have risen. I’m also keeping a close eye on my asset allocation. I’m trickling funds into low-yielding investments and solidly pulling away from passive index tracking ETF’s, moving more towards stock picking. I’m very liquid at this point, having well over 20% of holdings in cash and cash equivalents.

Full disclosure, while I think I’ve nailed my moves in the US and Canada, Europe was not as smooth as I failed to see how drastically EU financials would be hit by the one-two punch of low commodity prices and the negative interest rate policy of the ECB. So for example, the summer trimming of gains from the midcap ETF IWR was a smart move. However, I missed my shot with the European ETF FEZ which peaked back in mid-2014. On the other hand, picking up solidly yielding Canadian banks, such as Bank of Nova Scotia (ticker: BNS), back in February was a smart move.

The Rolling 1-Year Chart for Bank of Nova Scotia

I’ll continue to do this slow trimming, divesting and reinvesting and looking for strategic opportunities as the rally continues.

It Pays to Become a MyAssetClass Contributor

MyAssetClass pays you as much as $500 to contribute articles on your best and current experiences with value investing. The MyAssetClass.com forum focuses on the broad principles of value investing and publishes compelling and engaging content which will affect your decisions.

While investment strategies are personal, and this investor discussion forum doesn’t give investment or financial advice, there are some common tenets of value investing that can be better understood by structured and focused discussions with other like-minded investors.